The return of Freddie and Fannie?

Fannie Mae and Freddie Mac will go out of business, but what’s up for debate is what will replace the two companies, which helped fuel a massive, decades-long expansion in home ownership by pumping massive amounts of money into the mortgage system.

A bill gaining steam in the Republican-led House would replace Fannie and Freddie with at least five new private companies, each of which would buy and resell prime mortgages. The bill’s sponsors, Democrat Gary Peters of Michigan and Republican John Campbell of California, liken the new companies to utilities, although the mortgage-backed bonds these companies would sell would carry an explicit federal guarantee. If the loans in these new bonds soured, taxpayers would be in line to pick up the tab and make bond investors whole.

The new system would look uncomfortably similar to the mortgage regime the bill seeks to replace. In both models, private companies buy mortgages from banks, and then resell them to investors, with guarantees against defaults. The House bill would actually deepen the federal government’s involvement in the mortgage market; it would have the government explicitly back mortgage bonds, whereas Fannie and Freddie had long insisted their own guarantees weren’t backstopped by Washington.

The issue of the guarantee is key. A federal guarantee would subsidize the profits of the new private mortgage firms the bill would set up. And it would preserve the conflict of interest that led to Fannie and Freddie’s implosion in the first place.

Since Fannie and Freddie enjoyed an implicit federal backing, they could borrow money more cheaply than private firms, undercutting competition. Wall Street chafed at the government-sponsored enterprises’ built-in advantage. That’s one of the reasons the big banks jumped so eagerly into the subprime mortgage game: It was a lucrative pocket of the market that Fannie and Freddie traditionally shunned, leaving the mortgage-bond business, and the buckets of fees that came with it, all to the Street.